The New Monetary Orthodoxy is Wrong: To Be a Strong Nation, You Need a Strong Currency
by Andrew Alexander
The views represented in this article are solely those of the author and may not be construed as in any way representative of the views or policies of Oxford Royale Summer Schools.
On many occasions I have found myself in this country or that wishing there was something equivalent to a stock market for nations.
Every time I go to Canada I come away deeply bullish – the mixture of young, dynamic cities, resource wealth, open land and so much of the world’s fresh water covers most bases. Even with their housing market poised for a crash, it’s hard not to be impressed with a country that has African resources levels, Singaporean infrastructure and American can-do. At the same time, I have had the uncomfortable experience of being in at least two darlings of the investment scene – frontier markets growing at 8% a year – and seeing at first hand how the growth was largely a mirage, a mechanism for channelling resource wealth to a tiny oligarchy while the general population, most of the central government civil service, all of the state government civil service and all of the poor had no literacy and no skills other than brute labour (and even this meant nothing, given the epidemic levels of malnourishment and stunted growth). I would have taken a contrarian position and sold those nations.
Of course, there isn’t a stock market for nations, but there are approximations. There are the bond markets, which offer an assessment of a country’s prospects in the price at which investors are prepared to lend to its government. I would be cautious about using this metric, and more so now that QE has had such a distortive effect on bonds. As I frequently point out, the government of any given country usually comprises a collection of its weakest individuals. While some aspire to high office for the commendable motivations of patriotism and a sense of public duty, the majority do so for the simple pleasures of telling other people what to do and spending other people’s money. It is hard to take the actions of government as necessarily representative of their people, and while governments often show the worst half of their nation’s economy, they seldom show the best. Buying or selling US treasuries is a vote of confidence in the US political system, probably the most hysterical and noxious in the Western hemisphere. It touches on the economic prospects of the other USA – entrepreneurial, patriotic, rich and dazzlingly successful – only incidentally.
Even if one were to go against this argument – and you could do so entirely plausibly by arguing that the government was borrowing through the bond markets money that the rest of society would have to repay – you then must face up to near universal developed market quantitative easing, which is deliberately designed to inflate bonds to the point where they all offer a similar, very low yield.
In the absence of functional bond markets, we are left with currencies as our proxy for buying and selling the fortunes of nations. In recent years, these have also been pummelled by quantitative easing, but they remain fascinating precisely because unlike bonds, which tell us about governments, and stock indexes, which tell us about a small number of largely international firms, currencies are our live data point for the rise and fall of nations in relation to their rivals; the only hard number you can put against the intangible feeling of success and failure in the greatest race.
One example should suffice. Let’s take cable (American dollars per British pound) over the years. In 1900 with the British Empire at its zenith, the British Industrial Revolution complete while America’s still caught up, and sterling as a reserve currency, £1 = $5.40. With reserve status transferring to the dollar and Britain hollowed out by two world wars, the rate fell from a fixed £1 = $4 after the Second World War to just under £1 = $3 by 1949 and then into a spiral downwards through the economic turmoil of the 1970s and 1980s which brought it near to parity in 1985. Today sterling recently broke through a six year high against the dollar at the £1 = $1.70 mark, an accurate reflection of a stronger British employment recovery from the recession (where the UK has added full-time private sector jobs and lost public sector ones, while the US has seen a vast rise in part-time jobs in exchange for full-time positions as US firms attempt to escape their obligations under Obamacare). In this data we can see (and indeed, represent graphically and numerically) a trend that has affected the entire world – the shift from one Anglosphere hegemon to its successor over time. In this way, currencies don’t only tell us about prices, but also about the relative power of nations.
Students of economic history will find that there is no such thing as a settled orthodoxy. Take debt, for instance, which has gone within the space of a century across the Western world from being at one point a necessary evil at times of war and a plague, to be avoided at times of peace, to a primary driver of growth to the point where the Labour Party spent much of this parliament accusing the Chancellor of being irresponsible in not borrowing more while rates are low, as this was seen as wantonly disregarding the source of economic growth.
This is particularly true in respect of currencies. For many years, a strong currency and a strong nation were ideas that were intertwined. The British affection for the gold standard, the British willingness to join every fixed exchange rate scheme with the pound massively over-valued (the same tendency leading both to the humiliating devaluations of the post-war years and the Black Wednesday debacle), the Clinton administration’s strong dollar policy, the Bundesbank targeting a strong deutschmark – all these were symptoms of a mind-set that persisted until relatively recently, which chased strong currency as a national economic good.
Then came the great crash of 2008. From this point onwards, orthodoxy has been stood on its head. Central governments creating money to shore up their own debt obligations is something horrific to the idea of sound money. As a consequence, a considerable amount of effort has gone in to making the argument that sound money itself is abhorrent and ruinous. From dollar to sterling to euro to yen, every major currency has been enthusiastically devalued by its custodians in order to meet the demands of the new era. Indeed the Swiss franc was devalued not because of a pressing internal need for the poison pill of QE but in order to keep pace with what was seen as the highly desirable death spiral that the euro appeared to be in at the time in mid 2011.
Recent strength in the British pound has already found plenty of detractors. It is the “relentless strength of sterling” that is responsible for weakness in the stock market and particularly in the shares of exporters, analysts have warned. Others such as John Mills, the economist, have argued that we should actively seek to devalue in order to grow our manufacturing sector. The howls of exporters whenever the pound ticks up against the euro or dollar are the dominant intellectual strand of thought on currencies and have been for since the start of this crisis when nations began to chase one another’s shrinking domestic markets by seeking to lower the comparative price of their exports. Not only does this add to GDP, but the consequent increase in the price of foreign goods in the home market limits imports (which also improves one’s own GDP figure). Sir Mervyn King, former Governor of the Bank of England, is even on record claiming that a significant part of his post-crisis master plan was to force the sterling exchange rate down 25% across the board.
Strength in numbers
In my view, this thinking is entirely wrong. Indeed it is symptomatic of the great economist’s vice of pushing forward blunt models that work in the classroom (lower currency = lower imports + higher exports = higher GDP) without giving any great thought to the question of how a modern economy actually works.
This is particularly wrong in the case of a country with an economic profile like Britain’s. There are a number of reasons for this, which I will separate below:
1.The structure of British imports and exports
It takes an extremely long time to restructure a modern economy and in some cases it is not possible to do so at all. The British economy is a huge exporter of services – largely high-value intellectual property and financial and consultancy services. We sell expertise and high-quality manufactured items, if we sell them at all. We do not, at this point in time, have either vast energy reserves (we are a net importer of fuel) or a thriving manufacturing industry converting raw materials (which again, we need to import) into low margin, mass-produced finished items.
Given an economy of this structure, a strong pound is very helpful. As we have a structural need to import energy, raw materials and low-value manufactured items (we do not have sufficient stock of the first two and our wage expectations are too high to compete on the latter), we will do so whether prices are low or high –in other words, these are price inelastic in Britain. As such, all a weak currency does is push up domestic inflation by increasing the sterling price of goods. This actually hurts our high-quality manufacturing base as they need to buy raw materials from abroad and their energy bills are higher at home, limiting any export gain. Likewise, our service industry is unmatched outside America – our offering, particularly in finance, is very price inelastic as it doesn’t exist elsewhere. Foreign buyers will bear the cost of price increases because they have to; there is no alternative. In these respects strong sterling is actually a net positive for GDP.
2. Consumption effect
At a time of economic stagnation, wages are likely to freeze or grow slowly. A falling currency nevertheless pushes up the price of essentials. This means that consumers make fewer purchases and experience a fall in living standards. Because less money is circulating in the economy, the volume of goods and services sold falls, distributing money less evenly and sending a larger portion of that money abroad at the expense of domestic suppliers of more marginal items; this locks the economy into a spiral of worsening economic conditions.
3. Investment effect
On another level, the less money is available for non-basic expenditure thanks to the rising price of essentials owing to a falling pound, less is saved and therefore less is invested too. The lack of investment has a disproportionate effect on the future economic health of the economy and the opportunity cost is the future returns that would have been enjoyed had that investment taken place. Again, in this case a weaker currency now invites a weaker economy tomorrow.
These are points which have become lost in the new orthodoxy. Nevertheless, they are coming back into the economic mainstream. It was pleasing to see John Redwood, the most intellectually brave of MPs, discuss a “virtuous circle” earlier this month in which a higher pound drives down inflation and allowed families to spend more therefore sustaining economic growth. It is a much more compelling story than the usual dirge about the harm sterling does to exporters of the type that ceased to exist along with Raj.
A strong currency is, for an advanced economy like Britain’s, not just a marker of, but a prerequisite to a high standard of living and a thrusting economy. Currency devaluation is not only weak in the great sweep of history but demonstrative of a low standard of intellectual thought today. Let us hope that the strong pound is here to stay.